30 August 2013

Bundesbank/Weidmann: Banking supervision and regulation - What action does the Bundesbank consider necessary?

The crisis has revealed a fatal feedback loop between government finances and the banking system. To solve this problem we need two approaches, each working in tandem with the other.

1. The banks themselves have to increase their resilience: Basel III has now been transposed into EU law, significantly tightening capital and liquidity requirements.
2. We need to loosen the close ties between banks and governments.

In my view, there are two main components to this second approach: first, better rules restricting banks’ balance sheet risk arising from government debt holdings and, second, the banking union.

We want to ensure that banks' economic situation no longer depends so heavily on the solvency of their home country. We can only achieve this if we stop giving government debt preferential regulatory treatment over other loans or securities. Government debt should therefore be backed with a level of capital which adequately reflects the risks it carries and caps should be imposed on bank sovereign debt holdings.

We also need to minimise the implicit government guarantee for systemically important banks as far as possible. To achieve this, we will need both higher capital requirements and stricter banking supervision which is not geared to national interests. In addition, the cross-border effects of bank turmoil also mean that we need a harmonised approach to bank restructuring and resolution.

Challenges in banking supervision and regulation

Let's look at the SSM first: the plans for its institutional structures are now largely in place. Yet we still face certain organisational challenges, particularly concerning the organisational set-up of banking supervision at the ECB and the process of setting common supervisory standards. While the compromise reached on the SSM's institutional structure will allow a swift transition to European-level banking supervision, it does not separate monetary policy and banking supervision strictly enough.

To separate monetary policy and banking supervisory tasks effectively, it will be necessary in the long run either to reform the institutional basis upon which the ECB is founded or create an independent European banking supervisory authority. Swift steps should be taken to initiate the treaty change that this will require.

The process of setting up the Single Resolution Mechanism (SRM) also poses certain institutional challenges: When a bank is restructured or resolved, there should be a sequence of liability, defined clearly ex ante, in which private funds – not public money – are the first port of call. This means that European taxpayers will no longer have to form the first line of defence.

The European Commission put forward a proposal for the SRM's institutional framework in July. One welcome aspect of this draft is that it includes the guidelines for burden-sharing. Nonetheless, I take a critical view of the leeway that the draft would allow Member States in their restructuring decisions. In addition, the Commission proposes creating a European Resolution Fund and making itself responsible for resolution decisions. This is problematic under EU law. The existing EU treaties do not provide for such a transfer of responsibilities, which could also have far-reaching financial implications for the Member States. Treaty change would therefore be needed to provide a rock-solid legal basis for these measures, too.

Essentially, in the legal groundwork for the SRM it is more important to be thorough than to be fast.

Full speech

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